Patent war brews big bucks

The morning that Michael Risch inserted himself into the battle between a Fortune 100 company and the man known as the "father of the iPod" began like any other, with a wake-up call from his six-year-old son. Risch, a professor of intellectual property law at Villanova University, padded to the kitchen of his suburban Philadelphia home and — in a move that his wife hated — joined his family at the table, laptop in hand.

Of interest this morning was a new message from Article One Partners. For the past three years, Risch had moonlighted as a researcher for the company, which represents clients who are being sued, or are about to be sued, by someone who claims they're infringing on a patent.

Article One posts the disputed patent online for Risch and the rest of its 20,000 researchers to see. What it's hunting for is called "prior art" — magazine articles, brochures, or other published evidence that could show that the patent is invalid and therefore not worthy of a lawsuit.

What it offers in return are large cash rewards, sometimes as much as $50,000, which explains why Risch's wife tolerates the way he divides his mornings between his kids and his computer.

"I've probably won enough to pay for a year of college," Risch says. "Though by the time they go, it'll be half a year."

For privacy's sake, Article One doesn't provide the name of the company being sued or the company doing the suing. But from the title of this message — "Controlling an HVAC system from a remote location" — it was clear to Risch that the fight was over that most mundane of household appliances: the thermostat. This was right in his wheelhouse.

The son of an electrical engineer, Risch grew up a tinkerer. At age 13, he took apart and rebuilt his first computer, a Commodore CBM. The ability to understand how a machine works, along with his law degree, came in handy in the early '90s, when a booming software industry was suddenly in need of people with just such a skill set. Academic work had moved him from court to classroom, but it hadn't dulled his interest in patents, or in figuring out how things work.

Still in his pajamas, Risch took to Google and joined the hunt.

Not long after breakfast, he submitted five items that suggested that the idea of controlling a thermostat from somewhere other than home wasn't original. At lunchtime, he submitted another. And at 3:59 p.m., moments before his two boys woke from their afternoon nap, he sent in his final submission, the one that would eventually garner him an even split of Article One's $5,000 reward.

Risch may not seem like anything more than a multi-tasking dad in the digital age. But he actually represents something else: He's a player in what's come to be known as the patent Cold War.

Born Broken

Around the time that the original Cold War was beginning to defrost, a new arms race began. This one involved billion-dollar companies, many of them in the growing tech industry. Rather than real nuclear warheads, the battle involved metaphorical ones, and they came in the form of patents. And instead of producing an unsteady détente, this litigious sequel has seen more than its fair share of mushroom clouds. In just the past year, companies have spent more than $20 billion arming themselves with stockpiles of patents.

Google, Microsoft, Apple — these are the new global superpowers. And depending on the day, one, two, or all three of them are firing missiles at their competitors via patent suits or signing promise-we-won't-shoot peace accords — sometimes both at once. And because our economy has become so dependent on computers, smartphones, and the software that runs on both, the entire industry is singed by the collateral damage.

To get a sense of why people like Apple CEO Tim Cook think the patent system is "broken," or why Google spent $12.5 billion last August to buy 17,000 patents, take a look inside your pocket. Chances are good that you own a smartphone. But what you may not know is that your phone has 250,000 other owners.

That's how many patents cover the average iPhone, Galaxy, or Droid. There are patents on the semiconductors inside, the touch screens outside, and even the invisible signals that allow you to check your e-mail. Sometimes hundreds of patents cover the same function.

The problem begins — as it often does — with the federal government. Specifically, the United States Patent and Trademark Office.

The U.S. Patent Office has been a controversial arbiter going all the way back to the 1800s, when it required applicants to submit working models with their inventions, a practice that ended because the office ran out of storage space — and because the attic in which the wood models were stowed kept catching fire.

According to Kara Swanson, a law professor at Northeastern University in Boston, the agency has always been a punching bag. When the pendulum swings too far to one side, applicants claim it's too hard to get a patent, and thus too difficult to protect their inventions. When it swings the other way, these same applicants claim the process is too easy, and thus too hard to protect themselves from others who claim they've invented the same thing.

Caught in the middle are the agency's examiners, a perpetually underpaid, understaffed group that is constantly being asked to make a choice: grant few patents and get yelled at, or grant a lot and suffer the same fate.

"That's why I love the patent office — because they have a constitutional mandate for an impossible task," says Swanson.

In the past 30 years, as our reliance on computers has grown, so have patents. Since 1980, the number of applications has tripled. It took the feds more than a century to grant their millionth patent. It took only five years to go from seven million to eight million.

Many factors contributed to this gold rush. The first was the creation, in 1982, of a new federal court established specifically to hear patent disputes. Unfortunately, the court was staffed by lawyers with a clear bias toward those whose patents were being challenged. A succession of rulings subsequently expanded the already-wide limits of what could be protected and what couldn't.

Finally, while it might be easy to understand what's new about a saw, it's much harder to assess the originality of something that exists only in a line of computer code.

But perhaps the single biggest reason for the patent explosion is that the agency's "impossible task" got a little less possible just when it was needed most.

In 1991, right before the gold rush began in earnest, Congress changed how the patent office got its funding. Rather than being financed by taxes, the agency would now have to fend for itself using only the fees paid by applicants.

With that directive, lawmakers essentially gave the agency an incentive to grant more patents — and that's exactly what it did. Melissa Wasserman, a law professor at the University of Illinois, notes that the office grew especially generous toward large tech companies, since they were the most likely to keep their patents up to date by paying costly renewal fees, and thus brought in the most money.

"Take semiconductors, for example," says Wasserman. "[Manufacturers] renew at a very high rate. Not necessarily because they make these successful commercial products, but because they just want this arsenal of patents."

Stockpiling Weaponry

Why companies began hoarding patents became particularly clear in the early '90s. A decade earlier, Texas Instruments was headed toward bankruptcy when it decided to start suing its Asian rivals for patent infringement. When those competitors agreed to pay hefty licensing royalties, the company realized it was sitting on a gold mine. Over the next three decades, Texas Instruments would make more than $5 billion from patent royalties alone.

To the kings of Silicon Valley, this pay-or-we'll-sue strategy initially seemed ridiculous. At a hearing in 1994, the most important tech companies of the day testified as to how patents were a negligible ingredient of their success. Adobe's principal scientist noted that the company had revolutionized the world of printing without a single patent. A representative from Cisco Systems said it had over $1 billion in annual revenue despite holding just one.

Then IBM, the country's leading patent holder, started cribbing from the Texas Instruments playbook. Suddenly, in the words of one software lawyer, the entire industry embarked on a "patent anything" approach.

In 1990, for example, Microsoft held only one patent. By the start of the next decade, that number had jumped to 800. Today it stands at an estimated 20,000, which doesn't include the many thousands more at its disposal through licensing deals and acquisitions. In April, the company spent $1 billion just to buy 800 patents from AOL.

Still, Congress wasn't done subverting the patent office. In 1992, a year after lawmakers said the agency could make money only from fees, they began diverting what would amount to $750 million over the next two decades. This prevented the hiring of new examiners at the very time they were needed most.

"The biggest problem of all was that the patent office didn't have examiners who knew anything about software," says Paul Michel, a former chief justice of the patent court set up in 1982. "There were lots of claims granted that never should have been."

Bob Stoll, the former number three at the agency, puts it more bluntly: "There's a lot of crap out there."

Stoll remembers his boss's reaction one year when Congress diverted another $90 million from the office. "He ripped the phone out of the wall."

But even if the agency had had enough examiners, that probably wouldn't have stopped the flow. Among its many flaws, the office's most fundamental is that it's much easier for an examiner to say yes than no. Like a prosecutor, an examiner alone bears the burden of proof. He's also under a time crunch — while the handsomely paid lawyers hired to persuade him have an infinite number of billable hours at their disposal.

To calculate just what kind of absurd damage this catch-22 produces, Mark Lemley, director of the Law, Science & Technology program at Stanford, set out to see how many people not only claimed to have invented wi-fi, but persuaded an examiner to grant them a patent saying as much. The final tally: 150. "They can't all be right," says Lemley.

So many patents have been granted in the past three decades that the companies applying for them often don't even bother to check what they say. When the general counsel of Texas Instruments was asked if he knew what was in each patent the company owned, he scoffed that to merely read them all would be a "mind-boggling, budget-busting exercise."

What's even more mind-boggling is that he was telling the truth. One Yale study found that it would cost $400 billion in lawyers' fees merely to read each one of the 40,000 software patents granted each year.

So a shortcut was developed to avoid all that pesky research. It's known as the "ruler methodology," according to testimony from Ipotential CEO Ron Epstein during a 2009 Federal Trade Commission hearing. Instead of suing each other, companies would meet in a conference room, put their stacks of patents on a table, and, rather than reading what was in each stack, they'd measure both with a ruler. The one with the smaller stack would end up paying the other for the right to not get sued.

This worked for a while — at least for companies large enough to afford a stack. When both sides are capable of unleashing enormous damage, trigger fingers get reluctant. "The best that can happen is nothing happens," as the general counsel of Novell once told The Economist.

But what everyone feared was the player with a stash of loose nukes and no concern for consequences. In the world of patents, they're known as trolls.

Rise of the Trolls

For as long as there have been patents, there have been trolls: companies that use them not to make something, but to take money from those who do.

In the 1860s, trolls went from town to town demanding that farmers stop using basic tools like plows or shovels — which they claimed, often correctly, to own patents on — or pay them a tribute for the privilege. Some got their money. Some got shot at. But all were reviled.

Trolls thrive when there are lots of patents lying around — and by the turn of the century, a decade into the "patent anything" age, there were more than enough for Nathan Myhrvold.

Myhrvold is a former Microsoft executive and the very public face of Intellectual Ventures, a Bellevue, Washington, company known derogatorily as the king of trolls. Since 2000, Intellectual Ventures has purchased roughly one out of every two U.S. patents offered for sale, amassing more than 30,000, good for the fifth-largest portfolio in the country.

Tom Ewing, an industry analyst and attorney who has followed Intellectual Ventures, says that it has more than 1,500 shell companies through which it sues and extracts hundreds of millions of dollars from the likes of Samsung, Verizon, and dozens of others.

It's a model Ewing likens to a Mafia shakedown. "Their basic approach is to come in and say, 'Nice product ya got there. Would be a shame if something happened to it,'" he says.

According to one study, patent troll suits have doubled in the past decade — with disastrous effects on the economy at large.

In the mid-'90s, a man named Martin Jones managed to convince the patent office to award him 34 patents, all of which covered variations on the same simple concept: tracking the position and progress of everything from a subway train to a UPS delivery truck.

Jones's company failed, but his patents found a second life when he began licensing them through ArrivalStar, a mysterious Luxembourg-based company. ArrivalStar has since sued more than 100 companies that offer delivery of packages or people, including giants like Home Depot and mom-and-pops like 11-employee EarthSearch Communications, which got squeezed for $15,000.

Two years ago, ArrivalStar began hunting slower game, targeting cash-strapped public-transit agencies that offered their customers updates on the status of buses and trains. After paying the company $80,000 to go away, a lawyer for Seattle's King County said that it was the first patent lawsuit the city had ever seen.

A few years ago, Iconfactory, an 11-person graphic-design company in Greensboro, North Carolina, made waves when it introduced Twitterific, the first — and some still say the best — Twitter app. Then Iconfactory got a cease-and-desist letter from an infamous patent troll named Lodsys.

Lodsys owns only four patents. But one seems to apply to the entire smartphone industry: a patent that it claims covers any purchase made inside of an app, such as buying a movie ticket from Fandango. Lodsys had built a toll on the busiest road in town and now wanted a cut of every sale of Twitterific. Iconfactory had a choice: It either could spend millions it didn't have taking Lodsys to court, or it could settle, as so many others had done before.

Because of a confidentiality agreement, Iconfactory partner Craig Hockenberry can't say how much his company eventually paid Lodsys. But the emotional toll was more harmful. Whereas Hockenberry once woke up every morning "itching to write code," he started questioning whether he even wanted to be a software developer after the Lodsys shakedown.

"Everybody focuses on the percentage of money that was spent to license the patent," he says. "To me, that's actually less damaging than what's done to your spirit."

Hockenberry has watched colleagues abandon projects for fear that they could end up getting "Lodsysed." "They know that if I'm vulnerable, they're vulnerable," he says, "which means we don't know what next great thing might never get made."

Turning Up the Heat

Around the time that Nathan Myhrvold was creating new problems for companies, Cheryl Milone was thinking of ways to solve them.

Milone was a patent attorney in New York City, watching from the frontlines as the number of lawsuits — especially those involving trolls — exploded. She knew that it could cost a million dollars or more just to do the research necessary to invalidate one patent, which is why so many big companies relied on the "ruler method" and so many small ones either settled or closed shop.

Suddenly, she was struck with an idea: What if she could turn millions of amateur researchers into patent sleuths?

Her idea turned out to be unoriginal. A Boston company named Bountyquest was already investigating how it could do the same thing.

But despite support from Amazon founder Jeff Bezos, Bountyquest was about to become another dot-com-bubble anecdote: One day in 2001, its founders boarded a flight to go meet with the company's backers. By the time their plane landed, their funding had disappeared.

In 2008, Milone decided to refashion the bones of Bountyquest into Article One. She believed that the power of large, like-minded crowds on sites like Facebook and LinkedIn could be unleashed on something even as wonky as patent law.

That power was in full bloom late last year, when the world started seeing something it had never seen before: ecstatic praise for a new thermostat. It was called Nest, and the fact that it looked like an Apple product wasn't a coincidence.

Nest was created by Tony Fadell, who helped make the iPod. He was building a home in Tahoe when he realized that nearly every feature in it could be as beautiful as the products he had once helped manufacture. Every one except the thermostat.

"They were ugly. They were confusing. They were incredibly expensive," Fadell told Wired last year. "I was like, 'Why is this?'"

Thermostats hadn't changed much in half a century. Honeywell was the market leader; its basic design had gone untouched since the Eisenhower administration. Programmable thermostats, which were supposed to save people money, actually did the opposite, because they were so hard to program that homeowners eventually gave up.

When Fadell realized the potential market — everyone needs a thermostat — he convinced a few former Apple colleagues to quit their jobs and join him in a garage he'd rented in Palo Alto. Nest solved the problem of programmable thermostats by not needing programming. The equipment itself learns how to set the temperature based on time of day, season, and homeowner preference.

Last November, Nest sold out of its first batch in less than a week. The New York Times called it "elegant" and "very smart" and asked, "Can you imagine what the arrival of the Nest and its team of former Apple superstars must be doing to morale at [Honeywell]?"

It didn't take long to find out.

Shortly after Nest's launch, a Honeywell executive told tech site GigaOM that the company had the ability to make a learning thermostat 20 years ago but didn't because — despite all evidence to the contrary — they figured customers actually enjoyed programming their own.

In January, a writer for Fortune made the mistake of telling Honeywell CEO Dave Cote that Nest was selling really well. "Nest hasn't sold really well," Cote snapped back. "The New York Times has written about it really well."

Honeywell had used the same patents to stop two previous competitors. (The company declined to comment for this article, as did Fadell.) But Nest wasn't a typical startup. Along with its "former Apple superstars," it also had deep pockets. Fadell soon countersued, calling Honeywell "worse than a troll." He also got in touch with Article One.

It wouldn't be long before a still-sleepy-eyed Michael Risch would make nearly three grand from a few hours of Googling, which called into question Honeywell's patent claims.

The story might seem to point to a calmer future for the tech industry. Twitter just introduced a first-of-its-kind contract that says it will not sue a competitor for patent infringement unless the engineer who created the product signs off first, a plan that will hopefully subdue suits, given the live-and-let-live attitude of most developers.

Judges inundated by massive lawsuits seem to be losing their patience as well. One recently made news when she demanded that the CEOs of Apple and Samsung meet face-to-face to settle their differences. And last September, President Barack Obama signed into law the America Invents Act, which allows the patent office to hang on to more of its money — and to hire more examiners.

But Twitter is the exception, not the rule. The Apple-Samsung CEO sit-down solved nothing. And while the America Invents Act did make it harder for Congress to loot the patent office, it didn't make it impossible.

Nor did it do anything to stop the continued flood of new patents streaming out of the agency: Last year the office set a new record by granting nearly 250,000.

There's also a newer, even more unsettling problem: The big companies that once complained about trolls are now treating them like role models.

According to the New York Times, last year was the first in which Apple and Google spent more on patent lawsuits and acquisitions than they did on research and development for new products. In August, Apple won a $1 billion patent-infringement judgment against competitor Samsung.

Nest may have deeper pockets than most, but they still aren't as deep as Honeywell's. In early October, Nest announced that six of Honeywell's seven patents had been rejected in re-examination by the patent office. Yet Honeywell has so far refused to budge.

Which means that, ultimately, Nest may be the next to learn the most important rule of modern invention: The best weapon against someone else's patents is a stockpile of your own.